IB Economics Higher Level Paper 3
1. The diagram below shows the demand and cost curves of an imperfectly competitive firm that operates as a profit maximizer.
(a) Using the labeling on the graph identify and explain the
(i) quantity level of output (1 point)
(ii) price charged by the firm (1 point)
(i) Q2 is where marginal revenue = marginal cost
(ii) P5 is the Profit Maximizing Price
(B) Explain, at the profit maximizing level of output, if the firm achives (i) Productive Efficiency
(ii) Allocative Efficiency
(i) Productive Efficiency is when P = Minimum of the ATC (Costs are lowest)
(ii) Allocative Efficiency is when P = MC or (MB = MC)
Allocative efficiency shows the quantity and price that a perfectly competitive firm would produce if laid over the top of this monopoly. It shows the socially optimal quantity
(ie) the quantity of the good that society desires.
(C) Now suppose the firm seeks to maximize revenues.
(i) The quantity level of output
(ii) The price charged by the firm
Maximizing Revenue is found where MR = Zero
(i) The Revenue Maximizing quantity is Q3
(ii) The Revenue Maximizing price = P3
(D) (i) Define Normal profits
(ii) Identify the price and quantity the firm would charge to earn a normal profit?
(i) A Normal Profit (Zero Economic Profit) is when the firm is covering all of its explicit and implicit costs.
Explicit Costs = Fixed Costs & Variable Costs (anything you spend $ money on)
Implicit Costs = Opportunity Costs = what you could have been doing, given up
(ii) P3 & Q3
(Understand that P3 & Q3 just happen to be where Revenue is Maximized, it isn't always)
A firm is breaking even when its
1. Producing where P = ATC sometimes labeled as D = ATC
2. Called Breaking Even or Fair-Return as (TR = TC)
3. When a firm is breaking even it is covering all of its explicit and implicit costs, and if forced to produce at break-even, it will not need a subsidy to continue to produce in the long-run.
2. Asepsis Corp. operates in an imperfectly competitive industry producing hand sanitizer called Sani-Gel. The company currently produces the profit-maximizing quantity of Sani-Gel
but is operating at a loss. [4]
(a) Draw a correctly labeled graph for Asepsis Corp. and show
-
(i) The profit - maximizing output, labeled as QM
-
(ii) The profit - maximizing price, Labeled as PM
-
(iii) The area of loss shaded completely
Imperfectly Competitive = Monopoly
Losses, so P < ATC
(b) Assume that Asepsis is operating in the short-run. Amend the diagram from part a)
AND write an explanation in the box below to demonstrate how the firm can remain open in the
short-run while still operating at a loss.
(b) The firm will continue to operate as long as the Price > than the AVC
3. (a) Complete the following table for McLovin’s:
(b) Identify and explain the point at which McLovin’s begins to experience the law of
diminishing returns
(b) Diminishing marginal returns occur when the MP start to decrease
DMR first occurs with the hiring of the 5th worker
4. The table below shows the total costs of production for STC Inc.
(a) State the value of STCInc.’s fixed costs.
(a) If the output is zero and there is a (TC) total cost - then that has to be Fixed Costs
When output is zero it implies that the Variable Costs is zero but Fixed Costs are 15k.
(b) Calculate the value of STC Inc.’s average variable cost if it produces 100 Lbs of output.
With an output of 100 lbs the TC is 33K - 15k (FC) = VC = 18k
(c) With reference to the data in the table, explain why STC Inc. achieves increasing
returns to scale as it increases output from 50 Lbs to 150 Lbs.
Recognize that MC = (Change in TC / Change in quantity)
Marginal Costs are falling which implies that Marginal Product must be increasing
Therefore the firm has Increasing Returns to Scale
